The policy rate and market interest rates are different

STEP 1Today's rate and tomorrow's rate

Interest rates come with a 'term'. The rate for borrowing overnight can't be the same as the rate for borrowing for 10 years. That is where we start.

Policy rates are set, market rates are traded

The policy rate from Lesson 13 is the central bank's target for the 'overnight' rate. It changes only at meetings, 8 times a year, and stays fixed until the next meeting.

A market interest rate, on the other hand, is set in the bond market every day, every moment. Rates are determined as government bonds issued to borrow money, corporate bonds issued by companies and bank bonds issued by banks are bought and sold. The most basic of these is the government bond yield, the rate at which the state borrows. The benchmarks are the KTB 3-year and 10-year in Korea, and the 2-year and 10-year in the US. A '3-year yield' means the rate you receive for lending for 3 years.

Which rate does my loan follow?

Loan rates also move differently depending on which rate they are benchmarked to. Floating-rate loans mostly follow short-term rates that reset every few months, so they move similarly to the policy rate. Loans that lock in a rate for several years, by contrast, are priced off the bank's cost of funding over that period, that is, market rates such as bank bond yields. So even if the policy rate falls, fixed-rate loans can actually become more expensive if market rates rise.

The same goes for companies. For a company borrowing through corporate bonds, the corporate bond market rate matters more than the policy rate. The rate the stock market uses as its discount rate is also closer to long-term government bond yields than to the policy rate. The discount rate you got a taste of in Lesson 1 connects directly to this market rate.

STEP 2A long-term rate is the average of future policy rates

Let's turn the 1-year vs 3-year deposit analogy into numbers. One simple formula explains why market rates move first.

Follow the numbers

1. NowThe policy rate is 3.00%, and the market expects it to rise to 3.50% in 1 year and 4.00% in 2 years
2. Average(3.00 + 3.50 + 4.00) ÷ 3 = 3.50%
3. BonusAdd a 0.3 percentage point term premium as compensation for the uncertainty of being locked in for 3 years
4. Result3-year yield ≈ 3.80%. The policy rate is still 3.00%, but the market rate is 0.8 percentage points higher

The numbers are a hypothetical example to show the principle; real bond yields are determined in a more complex way.

Two things follow. First, the 3-year yield is already higher before the policy rate actually rises. This is because the market prices in the future in advance, which is commonly called 'priced in'. Second, when the policy rate does rise to 3.50% a year later as expected, the 3-year yield may barely move, because it was already in the price. What moves market rates is not the decision itself but a change in expectations.

The term premium added as a bonus is compensation for the risk of having money tied up for a long time. No one knows for sure what inflation or the government's finances will look like in 10 years, so the longer you lend, the more you want to be paid. This premium grows when government debt rises quickly or inflation outlooks become uncertain.

See it in a chart: the market prices in the future

Press a button or move a slider. The bars are the policy rate expected each year, and the orange dotted line is the 3-year yield those expectations produce. The black line is today's policy rate.

Press 'Cuts expected'. Today's policy rate is 3.50%, but the 3-year yield falls below it. A market rate below the policy rate is generally a signal that 'the market expects rates to come down'. Conversely, with 'Like the US in early 2022' the policy rate is still near 0% while market rates are much higher. We check in STEP 3 whether that really happened.

Each maturity tells a different story

Even among government bonds, the factors they respond to differ a little by maturity.

• 2-year and 3-year: most sensitive to policy rate expectations over the next 1–2 years. That is why they are used to read 'the central bank's next move as the market sees it'.
• 10-year: in addition to policy rate expectations, it reflects long-term growth and inflation outlooks, the term premium and even how many government bonds are being issued. The Korean 10-year yield is also strongly influenced by the US 10-year yield.

The line connecting rates across maturities is called the yield curve, and the gap between short and long rates shows what the market thinks about the economy. This continues in Lesson 16 on the term spread.

STEP 3Interest rates in 2022, 2024 and 2026

Now let's read what the market expected from real charts. The black staircase is the policy rate and the colored lines are market rates.

Scene 1: 2022, the 2-year yield rose before the hikes

Look at the first shaded area on the US chart. In September 2021, the US 2-year yield averaged 0.24%, almost the same as the policy rate (0–0.25%). But as inflation surged, the market began to anticipate Fed hikes, and the 2-year yield rose to 1.44% by February 2022. The Fed's first hike came in March 2022. The market moved several months ahead of the central bank. In March 2022, the monthly average 2-year yield was 1.91% and the upper bound of the policy rate was 0.50%.

Scene 2: autumn 2024, the 10-year yield rose while rates were being cut

The second shaded area answers today's question. From September to December 2024, the Fed cut its policy rate by 1 percentage point. The 2-year yield actually rose from 3.62% in September to 4.23% in December, and the 10-year yield rose from 3.72% in September to 4.63% in January 2025.

Several interpretations circulated in the market at the time. Economic data came in stronger than expected, shifting expectations toward 'not many more cuts', and worries that inflation could pick up again and a rising term premium from growing government debt were also cited. The core point is the same. Just before the cuts, the market had already priced in large cuts, and when those expectations shrank, market rates rebounded upward. The fact that September was the point when rates were lowest illustrates 'priced in' well.

Scene 3: 2026, the market moved first again

The third shaded area shows the recent picture. The US 2-year yield rose from 3.47% in February 2026 to 4.22% in July. As inflation picked up again in spring 2026, the market expected another hike, and the Fed actually raised rates by 0.25 percentage points in September.

The Korean chart tells the same story. In October 2022, the monthly average KTB 3-year yield was 4.24%, more than 1 percentage point above the then policy rate of 3.00% (raised in October). The market was anticipating further hikes. Conversely, in January 2023, the month the policy rate was raised to 3.50%, the 3-year yield fell to 3.46%, below the policy rate. It was a signal that the market saw 'the hikes ending here', and indeed the Bank of Korea stopped hiking afterwards. In September 2026, with a policy rate of 3.00%, the KTB 3-year yield was 3.99% and the 10-year was 4.45%, meaning the market is pricing in the possibility of further hikes.

All figures are monthly averages. On a daily basis, the highs and lows can be even larger.

For stocks, this means: the market rate sets the discount rate

In Lesson 1 we saw that the multiple (P/E) tends to fall when interest rates rise. The rate in question is closer to market rates, especially the 10-year yield, than to the policy rate. That is why the stock market sometimes shakes more on days when Treasury yields move sharply than on rate decision days.

When reading rate news, first check 'which maturity moved and by how much' rather than 'did the policy rate change?'. You can see today's level and direction of the US 10-year and Korean KTB yields in the current regime of the Macro Map. Why growth stocks hurt more when rates rise is calculated in Lesson 17.

That is not always the case. If market rates rise because 'the economy is improving', the earnings dial grows too and stock prices can rise. You need to look at why rates moved, and whether earnings or the multiple moved more.